One of the key Kremlin figures, who intervened last autumn in the fight between Vladimir Potanin and Mikhail Prokhorov, has decided not to back Oleg Deripaska in his hostile takeover bid for Norilsk Nickel.

The figure, who declined to respond to requests for comment, had earlier taken Prokhorov’s side, when Prokhorov and Potanin failed to agree on terms for a sale and purchase of Prokhorov’s 25% plus one shareholding in Norilsk Nickel, the diversified global metals miner and Russia’s largest mining company. Prokhorov then drafted a deal with Deripaska, swapping his Norilsk Nickel stake for an 11% shareholding in United Company Rusal (formerly Russian Aluminium); plus $4.438 billion in cash. A purported cash balance of $2.7 billion was also agreed between the two as a deferred payment obligation. The effective price Deripaska paid, and Prokhorov received for his Norilsk Nickel stake, was $251 per share.

The terms were revealed by Mineweb in mid-December:

http://www.mineweb.com/mineweb/view/mineweb/en/page67?oid=42218&sn=Detail
At the end of the month, Potanin refused to bid higher, and Prokhorov closed his deal with Deripaska. The Russian anti-trust agency, Federal Antimonopoly Service (FAS), issued its approval of the 25% shareholding transaction on December 31. By then, Deripaska and Rusal had signalled it intended to go for control, announcing that it had sent a letter on December 24 to KM-Invest, a complex holding jointly controlled by Potanin and Prokhorov, offering to buy a 2% stake in Norilsk Nickel owned through KM-Invest.

This was an offer without a price; arguably, not an offer at all, but a declaration of hostile intention. According to the website posting, “UC RUSAL, the world’s largest aluminium and alumina producer, announces its intention to buy 2% stake in Norilsk Nickel from KM-Invest.”.

Litigation by Potanin to block KM-Invest’s unbundling and selling off Prokhorov’s stakes makes this a dead letter for the time being, but a very costly one for Deripaska. The effect of his intention was already evident – Norilsk Nickel’s share price rose to a peak in November of $335. That is 33% more than Deripaska had paid Prokhorov

According to a recent statement from Norilsk Nickel, Prokhorov currently holds 28.2% in Norilsk, while Potanin has a 25.3% stake. These numbers appear to count the indirect shared stake of 7.4% the two hold in Norilsk Nickel through KM-Invest. Norilsk Nickel itself currently holds a 3.9% stake.

The free float of Norilsk Nickel shares amounts to about 40%. The principal institutional shareholders are Templeton, Blackrock and JP Morgan Asset Management; their stakes range in size from 1.7% to 1.3%. Another 18.6% of the shares is held in much smaller blocs by a relatively large population of shareholders.

Rusal’s intention to take over Norilsk Nickel, buying Potanin out, or buying minority shareholders out and isolating Potanin, has been coyly intimated by Deripaska’s deputy and Rusal CEO, Alexander Bulygin: “We intend to create Russia’s first global diversified metals and mining company,” a website posting quotes Bulygin as saying. “Our company will join the ranks of the world’s top five metals and mining giants providing significant growth for the company to its shareholders and reinforcing the international reputation of Russia as a strong industrial state. This deal is prompted by the development of the global metals and mining industry and we believe that Norilsk Nickel’s shareholders, management and employees will support the establishment of a new world leader.”

Fearful of offending Deripaska before the outcome of Russia’s largest hostile takeover bid is decided, some Norilsk managers have intimated, as one claimed, that “there may be merits” to the takeover. CEO Denis Morozov is clearly sceptical, however, warning last month there are no synergies to warrant shareholder acceptance of a Deripaska offer, if one materializes. Inside Norilsk Nickel, a source told Mineweb, “there are different visions of the prospects, though the opinion as a whole is that Deripaska’s arrival would worsen the situation for management.”

On February 4, the Norilsk Nickel board issued a statement clearing the decks for a fight to repel Deripaska. Interros, the Potanin holding, did the same. Shareholders were warned that Rusal was “unfriendly”, and despite the “information war” suggesting the takeover, “NORNICKEL have not received from Rusal any offers, plans or other information, concerning possibility and prospects of the future association of two companies.” The board dismissed the media publicity – led by Catherine Belton, a Financial Times reporter – as “incorrect and premature”. Against the board, and before shareholders convene for an emergency meeting on April 8, a FT editorial has suggested “everybody also seems to agree that combining Rusal and Norilsk to create a Russian metals champion is a good idea.” The FT also declared: “If Rusal wants to acquire Norilsk, it should do so by launching a straightforward, transparent bid and avoid a classic Kremlin-orchestrated stitch-up.”

Bankers close to Rusal believe that Deripaska could secure his borrowing for a takeover bid against Norilsk Nickel shares, plus its cashflow. But the sum is staggering. If Deripaska’s advisors are correct in calculating that the market capitalization of Rusal and Norilsk Nickel would be greater than the sum of its parts, then it is near-certain a transparent bid to the market would oblige him to pay the control premium to reach 51%. That is likely to mean that shareholders will demand last November’s high of $335. To buy them out, Deripaska will have to stump up $16.7 billion.

In theory, this is possible. In practice, the bankers will demand that Deripaska produce a letter from the Russian government confirming there will be no tax claim against Deripaska, his Basic Element holding, or Rusal, that would undermine the new company’s market value, or lead to a form of renationalization. Such a letter was demanded by the bankers to the proposed Rusal IPO in London last autumn. Deripaska could not produce it; the IPO was aborted.

In the meantime, the federal tax authorities fired a warning shot, challenging the legality of a Basic Element tax scheme in court, and winning. The appeal is proceeding; Deripaska isn’t winning.

There is also a fresh problem: in December, in amended filings in the UK High Court, Deripaska’s shareholding partner Michael Cherney (Mikhail Chernoy) submitted evidence of Deripaska’s signature on obligations to share equally the asset accumulation he and Cherney supervised at Rusal, and then at Basic Element. Were Rusal to borrow to take 51% of Norilsk Nickel, the lenders are bound to oblige Deripaska to cover the sizeable contingency that would be payable, if the High Court rules that Deripaska owes Cherney; or if Deripaska settles with Cherney first, for fear of the ruling.

English advice to the Kremlin on how it should manage the Russian national interest has been unsuccessful for eight years. An editorial by the FT to tell the Kremlin it should allow Deripaska to make his deal with Norilsk Nickel’s offshore shareholders looks like a desperation measure. Belton’s reporting has added to the impression that whatever Deripaska tells Belton, he knows his support is slipping at home, leaving him with just one chance of pulling off a takeover — to make the case that he, rather than Potanin, is the London market’s darling.

At the Kremlin, Belton the messenger is already viewed as a partisan of enemy no. 1 – former Yukos proprietor, Mikhail Khodorkovsky, and his US subordinates still fighting to hang on to more than $1.5 billion in cash held in bank escrow in The Netherlands. When Potanin unveiled a Kremlin-approved share buyback move, designed to fortify against Deripaska, Belton’s message was that this was a dirty trick. “An executive close to Rusal, “Belton reported on February 4, “said management could pursue the buyback in favour of Mr Potanin, in doing so infringing shareholder rights…. the executive close to Rusal said that the sale of energy assets to fund a share buyback by management could erode rather than boost the rights of minority shareholders rights. ‘These measures as proposed should be of worry to any shareholder whether small or large,’ the executive added.”

The proposal that has been endorsed by the Norilsk Nickel board, according to its release on February 4, is to sell non-core electricity generation assets. As Mineweb reported last November, these comprise shareholdings in generating companies, transmission and power supply units, ranging from 1.6% to 65.15%; plus portfolio assets that include the all-Russia utility, United Energetic Systems (UES). Publicly listed and publicly valued for the most part, the total market capitalization of the 13 assets is about $21 billion. Bank estimates of the value of the Norilsk Nickel stake in this sum is $7.2 billion.

Potanin had proposed bundling these assets into a separate holding called Energopolyus, and floating the company to capture two premiums for Norilsk Nickel shareholders — the added value in the new company, and the premium expected to stick to the Norilsk Nickel share, after the spinoff was completed. Prokhorov voted his shares in Norilsk Nickel to kill this deal.

Potanin’s new move this month would see a simple sell-off of the shares. Russian law limits a buyback to a maximum of 10% of the issued shares, and at the current price, they would cost about $5 billion. Added to the 3.9% the company already holds, the buyback would give the pro-Potanin bloc a defensive wall of almost 40%. The 7.4% held by KM-Invest, but blocked by court action, would raise the takeover barrier to about 48%.

Only a buyout of virtually every other share in the market would assure Deripaska of the control he says he is seeking.

Negotiations are under way with the Kremlin to approve Potanin’s buyback defence, and in parallel counter the arrangement Deripaska and Prokhorov had offered, when they signed the 25% stake acquisition. At $5 billion, the buyback move tops the $2.7 billion set-aside by almost double.

On February 5, Potanin met President Vladimir Putin in Sochi. Neither is saying what they discussed. But Potanin’s confidence has become visible. The strategy against Deripaska also has the advantage that, in public at least, the Kremlin need say and do nothing at all. Loose lips sink ships, was the wartime poster warning. This time it’s London and Moscow calling at the same time – and the news is sinking for Deripaska: Kremlin blanks tank banks.